Idiosyncratic Volatility and the Cross-Section of Expected Returns
Turan G. Bali
Georgetown University - Robert Emmett McDonough School of Business
This paper examines the cross-sectional relation between idiosyncratic volatility and expected stock returns. The results indicate that (i) data frequency used to estimate idiosyncratic volatility, (ii) weighting scheme used to compute average portfolio returns, (iii) breakpoints utilized to sort stocks into quintile portfolios, and (iv) using a screen for size, price and liquidity play a critical role in determining the existence and significance of a relation between idiosyncratic risk and the cross-section of expected returns. Portfolio-level analyses based on two different measures of idiosyncratic volatility (estimated using daily and monthly data), three weighting schemes (value-weighted, equal-weighted, inverse-volatility-weighted), three breakpoints (CRSP, NYSE, equal-market-share), and two different samples (NYSE/AMEX/NASDAQ and NYSE) indicate that there is no robust, significant relation between idiosyncratic volatility and expected returns.
Number of Pages in PDF File: 29
Keywords: idiosyncratic risk, total risk, expected stock returns, size, liquidity
JEL Classification: G10, G11, C13
Date posted: March 3, 2006